FAS - Direxion Daily Financial Bull (3X) ETF

[skhatri]

Obviously the financials have been running lately.

 

Do you think that FAS is an aggressive way (3x bull) to play a series of potential interest rate increases?

 

Top holdings are Berkshire, Wells, JPM, Bank of America, Citi, Visa, and Mastercard.

[tng]

Because of the daily compounding nature of leveraged ETFs, you are not simply betting on the stocks going up, you are actually betting on them going up in a straight line. Take this simple example. Suppose you get +10% one day and -10% the next. You end up with 1.1 x 0.9 = 0.99. That is the "leverage decay" that people talk about (it's not actually a decay, but just how geometric compounding works). Overall, the financials may be higher in a year, but if it happens in a volatile manner with a lot of up and down days then you may end up with much less than 3x of the total return over that year. If it goes up in a relatively straight line, you would end up with more than the 3x return.

 

If you want to bet on the financials, just stick with buying the stocks. If you want to leverage, stick with the more conventional ways of leveraging up on them (buying warrants, options, or even simply margin, etc). If you want to bet on interest rates going up, you may want to specifically pick the companies that are more sensitive to interest rates (the financials that run money markets are a good candidate, the first 25 basis points is their entire margin). The leveraged ETF is actually a bet on increasing prices of financial stocks AND low volatility during that time (i.e. it goes up almost every day rather than going up and down every other day). Most people who use leverage ETFs only trade them intraday so they don't have to worry about the daily compounding aspect and how that is also a bet on whether the price moves in a relatively straight line or not over multiple days.

[skhatri]

That's really insightful thanks. And for what its worth, I dont think financials will go up in a straight line.

 

I'm more inclined to buy a non leveraged Regional banking index like KRE because it seems like the regional banks have less capital markets exposure vs the larger guys and can take advantage of a potential 25 - 50 bps interest rate hike (by increasing the pricing on the loans and not yet paying more for deposits).

[jawn619]

Because of the daily compounding nature of leveraged ETFs, you are not simply betting on the stocks going up, you are actually betting on them going up in a straight line. Take this simple example. Suppose you get +10% one day and -10% the next. You end up with 1.1 x 0.9 = 0.99. That is the "leverage decay" that people talk about (it's not actually a decay, but just how geometric compounding works). Overall, the financials may be higher in a year, but if it happens in a volatile manner with a lot of up and down days then you may end up with much less than 3x of the total return over that year. If it goes up in a relatively straight line, you would end up with more than the 3x return.

 

If you want to bet on the financials, just stick with buying the stocks. If you want to leverage, stick with the more conventional ways of leveraging up on them (buying warrants, options, or even simply margin, etc). If you want to bet on interest rates going up, you may want to specifically pick the companies that are more sensitive to interest rates (the financials that run money markets are a good candidate, the first 25 basis points is their entire margin). The leveraged ETF is actually a bet on increasing prices of financial stocks AND low volatility during that time (i.e. it goes up almost every day rather than going up and down every other day). Most people who use leverage ETFs only trade them intraday so they don't have to worry about the daily compounding aspect and how that is also a bet on whether the price moves in a relatively straight line or not over multiple days.

 

Great explanation. I've tried to explain it in simple terms but I always complicate it.

[orthopa]

Because of the daily compounding nature of leveraged ETFs, you are not simply betting on the stocks going up, you are actually betting on them going up in a straight line. Take this simple example. Suppose you get +10% one day and -10% the next. You end up with 1.1 x 0.9 = 0.99. That is the "leverage decay" that people talk about (it's not actually a decay, but just how geometric compounding works). Overall, the financials may be higher in a year, but if it happens in a volatile manner with a lot of up and down days then you may end up with much less than 3x of the total return over that year. If it goes up in a relatively straight line, you would end up with more than the 3x return.

 

If you want to bet on the financials, just stick with buying the stocks. If you want to leverage, stick with the more conventional ways of leveraging up on them (buying warrants, options, or even simply margin, etc). If you want to bet on interest rates going up, you may want to specifically pick the companies that are more sensitive to interest rates (the financials that run money markets are a good candidate, the first 25 basis points is their entire margin). The leveraged ETF is actually a bet on increasing prices of financial stocks AND low volatility during that time (i.e. it goes up almost every day rather than going up and down every other day). Most people who use leverage ETFs only trade them intraday so they don't have to worry about the daily compounding aspect and how that is also a bet on whether the price moves in a relatively straight line or not over multiple days.

 

Great explanation. I've tried to explain it in simple terms but I always complicate it.

 

+1

[Gopinath]

To invert, do you think shorting the levered etf's(Not necessarily the financials) would be a profitable one given a long enough time period? I think FRMO guys talked about this last year if I remember this correctly. Anyone has done this profitably?

[tng]

To invert, do you think shorting the levered etf's(Not necessarily the financials) would be a profitable one given a long enough time period? I think FRMO guys talked about this last year if I remember this correctly. Anyone has done this profitably?

 

The "decay" is not a real decay, so it is not positive expected value bet to short leveraged ETFs. Lets take that 10% example again and treat it like coin flips and look over 2 days. You have 4 possible outcomes: up/up, up/down, down/up, down/down and each movement is 10%. The possible outcomes are 1.1x1.1 = 1.21, 1.1x0.9 = 0.99, 0.9x1.1 = 0.99, and 0.9x0.9 = 0.81. The average of 1.21, 0.99, 0.99, and 0.81 is actually equal to 1, so this is a fair bet. Intuitively, this makes sense because we know a coin flip is fair. However, only one of the outcomes (up/up) is profitable. The "decay" that you see is the payoff tending to move towards the outcome that has many up-days. Over hundreds of days, this basically becomes a lottery ticket like payoff where there is a small chance of making a very large amount of money (you get a long series of up days) and almost everything else is a loser. As an exercise, you can try this with 3 or more "coin flips" and you'll see that the payoff gets lopsided towards the corner of the payoff matrix that favors getting a lot of heads.

 

Actually, shorting a 3x leveraged ETFs likely has negative expected value because stocks have positive expected value in the long run. The leveraged ETF has the same expected value as a normal unlevered ETF (ignoring fee differences), just that the payoff becomes lottery-like in the long run (few outcomes have outcomes that beat the unlevered version by a large amount, most outcomes trail).

[frommi]

In reality these 3x ETF`s do roughly what they are supposed to do, you can check this on etfreplay.com. For example UPRO has delivered 27% while the S&P had a 10% return, with a max DD of 21% vs. 7.27% for the last 12 month. And that was not a straight line up. 

 

 

[rpadebet]

In reality these 3x ETF`s do roughly what they are supposed to do, you can check this on etfreplay.com. For example UPRO has delivered 27% while the S&P had a 10% return, with a max DD of 21% vs. 7.27% for the last 12 month. And that was not a straight line up.

 

Ideal candidate for shorting leveraged ETFs are the volatility future based ETFs. Things working in your favor there are

1. No earnings to cause upwards drift

2. ETF fees (if you short them you implicitly earn the management fee)

3. Lots of volatility in volatility indices

 

risks are obviously you are prone to short term spikes. The way I used to do it a few years ago is by selling long term options (as vega on the options themselves was high as well). Have to be very careful with the position sizing though, cant get too greedy. This gravy train stopped for me when Credit Suisse/issuer stopped their leveraged vix ETF (TVIX if I remember). I tried this with VXX, but its just not the same

[frommi]

To short vola you can buy XIV, but who knows if the future looks like the past? :)

[stahleyp]

In reality these 3x ETF`s do roughly what they are supposed to do, you can check this on etfreplay.com. For example UPRO has delivered 27% while the S&P had a 10% return, with a max DD of 21% vs. 7.27% for the last 12 month. And that was not a straight line up.

 

From what I see in 2011, the market was basically flat, while this was down about 10%. I think the impact vary quite a bit with the related volatility.

[rpadebet]

To short vola you can buy XIV, but who knows if the future looks like the past? :)

 

You pay a management fee if you buy XIV.

 

you can sell 1y call options on VXX at strike =2xcurrent price and wait for time decay and the roll decay that is built into these futures based ETFs to slowly collect the premium. Again, you cant get too greedy and I am currently not doing it. I hope to do it when VIX spike above 20 or so and when there is a decent correction in the market.

 

The bet here is obviously volatility mean reverts and cant stay high for too long and that the term premium built into the futures curve is almost always steeply positive.

 

With the leveraged VIX product to short, you also had that geometric compounding thing working in your favor  ;)

[frommi]

To short vola you can buy XIV, but who knows if the future looks like the past? :)

 

You pay a management fee if you buy XIV.

 

you can sell 1y call options on VXX at strike =2xcurrent price and wait for time decay and the roll decay that is built into these futures based ETFs to slowly collect the premium. Again, you cant get too greedy and I am currently not doing it. I hope to do it when VIX spike above 20 or so and when there is a decent correction in the market.

 

The bet here is obviously volatility mean reverts and cant stay high for too long and that the term premium built into the futures curve is almost always steeply positive.

 

With the leveraged VIX product to short, you also had that geometric compounding thing working in your favor  ;)

 

Isn`t the volatility premium for options on VIX at its low point when VIX is high?

With XIV you pay a fee, but you get a limited downside and unlimited upside that way. I already feel bad when i short an unlevered ETF, i think i would never be able to stomach shorting a bouncing ball going against me. (Especially when it can easily wipe out my networth and a lot more.)